New York Markets After Hours

Bundesbank recovers the reins in euro zone

Commentary: Unemployment and competitive weakness key concerns

By

MichaelCasey

Columnist

NEW YORK (MarketWatch) — In the end, the Germans won.

Six months after European Central Bank President Mario Draghi stirred up a hornets’ nest in Germany by pushing through a plan to buy sovereign bonds over the Deutsche Bundesbank’s objections, no steps have been taken to implement it.

Yet even as Spain and Italy have balked at requesting a financial assistance program from the European Union that would trigger such purchases, the tantalizing prospect of ECB intervention has by itself spurred a rally in Spanish and Italian bond prices, with their yields plunging. Over that same time frame, the euro has gained 10% against the dollar and 25% against the yen.

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While this recovery reflects confidence that the euro zone will remain intact, it doesn’t mean Europe is out of the woods. What it does mean is that the Bundesbank’s deep-rooted German bias for strong money and price stability continues to hold significant sway over the ECB. Whether that’s to Europe’s advantage or not remains to be seen.

One question is how long will the rest of Europe can be comfortable with a strengthening exchange rate when much of it is mired in recession and desperate for an export-led recovery.

Jean-Claude Juncker, Luxembourg’s Prime Minister and the head of the Eurogroup of euro zone finance ministers, fired the first shot Tuesday when he reportedly said the euro was “dangerously high.” Juncker’s hyperbole doesn’t jibe with the ECB’s purchasing-power-adjusted trade-weighted exchange rate measure, which is actually below its long-term average. But it surely reflects the view of many struggling European businessmen, for whom a stronger currency is a drag on their competitiveness.

All this has happened without the ECB lifting a finger. In the six-month period since Draghi vowed to do “whatever it takes” to save the euro, the ECB purchased no bonds, made no adjustment to interest rates, and actually diminished its balance sheets. In stark contrast to how various German pundits depicted Draghi in the fall — when Alexander Dobrindt, who heads Chancellor Angela Merkel’s sister party, warned that the Italian central banker was becoming “the money forger of Europe” — the ECB has, if anything, modestly tightened monetary policy. Compared with the U.S. Federal Reserve, which launched an open-ended bond-buying program during that same period and vowed to keep rates near zero until unemployment drops to 6.5%, the ECB is abiding by a tradition of strong money policies.

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Last week, Draghi again managed to singlehandedly change the calculus of the world’s money managers. After the ECB kept its benchmark rate steady at 0.75% for the sixth month in a row, he declared in his monthly press conference that it was an entirely unanimous decision, that there was no discussion of the matter among its 23-member governing council.

That provoked incredulity. How, after all, could the governor of the Bank of Spain not even question the wisdom of keeping euro-zone rates above those of the U.S., Japan, U.K. and Switzerland when Spanish youth unemployment is over 50%? But the message was loud and clear: the ECB is retaining its singular focus on price stability, even if that creates some interim pain for many member states.

Inevitably, this hard-line stance is encouraging investors to buy the euro, which now promises to pay yields higher than the dollar, the latter being weighed down by the Fed’s hyper-easy monetary stance. And with annualized euro-zone inflation coming in Wednesday above the ECB’s 2% target, there’s no reason to believe the central bank will lighten up. Unlike the Fed, it has no mandate beyond price stability, no special charter requiring it to achieve full employment.

Yet unemployment and a lack of competitiveness are precisely what’s eating at the euro zone, especially in the crisis-ridden peripheral countries. That in turn partly reflects the unresolved structural flaws within the monetary union, which are neatly encapsulated in the one-size-fits-all framework with which Draghi and his colleagues must formulate monetary policy.

At the moment, that policy remains firmly aligned with the interests of the union’s biggest economy. But because of that, it also brings pain to the weaker ones.

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